Microsoft CEO Steve Ballmer told financial analysts in a presentation Tuesday that he sees an upcoming convergence of the PC and mobile device markets and expects hot-selling netbooks equipped with the upcoming Windows 7 operating system to deliver noticeably higher margins to Microsoft and its channel partners.

Ballmer also seemed to downplay the possibility of Microsoft (NASDAQ:MSFT) introducing its own smartphone anytime soon.

"People ask me, 'Will you build your own phone?' It's not our strategy to build our own phone," Ballmer said. "It's our strategy to sell software that we can use and support across a wide range of device manufacturers."

But Google's Android won't just be a threat to Microsoft's mobile business. While the company continues its efforts to stave off challenges in the operating system sector from Apple and Linux, Ballmer is looking ahead to a convergence of the PC and mobile device as the computing platform of choice and sees an Android-powered laptop on the horizon with Google entering the OS market.

In the netbooks sector, where that convergence is already evident, Microsoft enjoys a market share of roughly 80 percent with its XP operating system. The company is hoping for an aggressive push with Windows 7, an upselling strategy that would deliver significantly higher margins, Ballmer said.

In the traditional PC market, sales have slowed and will continue to trend down, Ballmer added.

"I have a basic theory that in the consumer market, the things that get hit most in this economy are going to be big-ticket items that are viewed as discretionary," like cars, flat-screen TVs and replacement PCs

"On the business side, we'll see the equivalent. We'll see a slow in capital spending. IT is about 50 percent of capital spend in developed markets, so we'll see a slowdown in IT spending and that will affect PC, PC hardware and server sales rates. This is definitely a business that sees the effects of the economy."

Aggressive Hosting Investment

The next big step forward in the company's Office line, version 14, will not hit the market this year, Ballmer said.

On the server side, Ballmer said Microsoft plans to invest aggressively in areas where the company lags behind Linux in market share, specifically targeting the areas of Web hosting and Web applications, as well as scientific applications.

In its enterprise software business, Microsoft is looking to compete aggressively with market leader Oracle (NASDAQ:ORCL) in the database and middleware sectors. Ballmer said he hopes to challenge Oracle in business intelligence, and also make inroads against the licensing agreements the database giant enjoys with large enterprises.

Internally, as it absorbs the recent layoffs, Microsoft is trying to move some of its people around to match its shifting priorities, Ballmer said, but that reorganization has presented its own set of challenges.

"It's not easy," he said. "It's not like you can take someone who thinks they're a video game designer and put them to work on SQL server. But we're doing some work to reshape our cost basis."

Grim Economy

With the grim economic climate weighing on all sectors of its business, Microsoft reiterated warnings about slowing revenues and profits for the second half of the year, but vowed prudent spending as the company looks ahead to new fronts in its war with Google.

Ballmer also noted that Microsoft'sfinancial team has taken to the history books, studying comparable crises of the past and trying to extract lessons to apply in the current downturn.

"They all have a story associated with them, and none of them is a quick recovery," he said. "That's kind of the mindset we have relative to the economic situation. You don't beat it, you manage in this environment."

He added, "It's not like anyone's able to cut costs fast enough in any industry to maintain the profits of yesteryear."

The strategy update comes a month after Microsoft reported its fourth-quarter earnings, when the company missed guidance and announcing the first layoffs in its 34-year history.

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